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namics have played out and S = I again, every r will be paired with asmaller Y in the new IS than in the old one. The IS curve will have shiftedto the left. The new intersection with LM will occur at a lower r* andlower Y* than before. Even though people are saving a larger fraction oftheir income, they will end up having a smaller income out of which tosave, with the result that S will increase by less than the marginal propensityto save. The final result, when S = I again, may well be that S will belower than the level at which we started. Thus, the effort of everyone tosave more in the aggregate could result in everyone actually saving less—the so-called paradox of thrift. In such a case, a higher savings rate inducedby fear of recession could itself cause a recession—a self-fulfillingprophecy.Now suppose there’s an increase in the efficiency of investment (anincrease in the marginal productivity of capital), thanks to a new invention.For example, many people claim that this is exactly what has happenedin today’s “new economy,” in which information technology issaid to have increased productivity. This would increase I, so that I > Snow along the old IS curve. With I > S, injections are greater than leakagesout of the circular flow, so the flow of income will grow until S = Iagain. The new IS curve will have a higher Y for each r. The curve shiftsrightward. The new equilibrium occurs with a higher Y* and a higherr*. An improvement in the marginal efficiency of capital raises both incomeand the interest rate.Finally, turning to the LM curve, suppose there was an increase in liquiditypreference, so that L > M. Such a change could result from increasinguncertainty over future economic conditions and a desire by people tobe prepared for the unforeseen with cash on hand. Alternatively, the deregulationof banking in the United States during the mid-1970s allowed certainchecking accounts to pay interest. This reduced the opportunity costChapter 17 The IS-LM Model • 331Box 17-4Junk Bonds and Timber CompaniesSeemingly abstract things like interest rates on bonds and Wall Streettransactions can affect real economic production and the provision of environmentalservices. For example, during the 1980s, hostile takeoversand the introduction of junk bonds on Wall Street led to deforestation onthe West Coast. How did this happen? Mergers, when two companiesjoin together, and acquisitions, when one company purchases another,are a normal part of corporate activity in the U.S. Sometimes, however,one company does not wish to be taken over by another. For example,mergers and acquisitions (M&A) focused primarily on short-term profits